Debt-Ceiling Deal Does Little For Global Economic Ills

With the fight over the U.S. debt ceiling finally over, investors are free again to focus on all the economic challenges that lie ahead, but they are finding little reason to celebrate. Stock markets around the world fell sharply on Tuesday, skipping the "relief rally" that customarily follows the resolution of a crisis.

In the United States, signs of a serious economic slowdown had been building up, though with attention focused on the debt-ceiling debate, the news had apparently not yet sunk in.

The U.S. economy, as measured by gross domestic product, barely grew in the first two quarters, manufacturing slumped and consumer spending fell in June for the first time in nearly two years. The stalemate over the debt ceiling only aggravated what was already a bad situation.

"Our economy didn't need Washington to come along with a manufactured crisis to make things worse," said President Obama, commenting on the approval of a new debt ceiling. He offered little hope for a quick recovery.

"It's pretty likely that the uncertainty surrounding the raising of the debt ceiling, for both businesses and consumers, has been unsettling," he said, "and just one more impediment to the full recovery that we need."

Even as he spoke, the U.S. stock market was tanking, as were markets in Europe, which is struggling with a huge debt crisis of its own.

"When everyone sees that global growth is slowing down — it's not just the U.S., we're also seeing China and Europe slowing down — they go, 'Oh no, it's going to be harder than ever to dig our way out of this mess,'" says Harvard economist Kenneth Rogoff.

Just last year, prospects seemed brighter. After the financial crisis, the global economy rebounded. But that growth has now stalled, in ways that indicate how the global economy is interwoven.

China, for example, has been booming, in part because of demand for its products in the U.S. and Europe. But with U.S. and European consumers and businesses cutting back on their spending, even China gets hurt.

"China is not collapsing, [but] it's notably slowing," says Rogoff, a former economist at the International Monetary Fund, "and it's being affected by the rest of the world. And all these things connect, so we're seeing all the major regions of the world slow down. It's not clear where growth is going to come from in the coming quarters."

Some economists say the global economic situation is as bad now as it has been at any point since 2008. Rogoff, the co-author of a book on the history of financial crises, points out that they are worse than standard economic crises. A slowdown typically follows a big financial crisis, he argues, because governments have to work so hard to get banks to lend again and consumers and businesses to spend again that they drive themselves deeply into debt.

"The U.S., Japan, and the euro area are all groaning under enormous burdens of public debt, and that is going to be a big drag on growth," says Cornell University economist Eswar Prasad. "The debt has to be financed one way or another, by cutting government expenditures on productivity-enhancing items like infrastructure and education [or by] higher taxes. This is not going to be good for economic activity in these countries."

For much of the developed world, the harsh realities add up to economic trouble. They could also produce some geo-economic realignments.

The new emerging market economies are in relatively better shape, even those affected by a reduction in exports to more developed countries. Consumers in those countries are making up for the losses, Prasad says, buying more of the goods produced at home. In addition, many of these new economies got their own budget deficits under control years ago, leaving them freer to do more stimulus spending.

"Most of the emerging markets have a lot more space in terms of their policies," Prasad says, "[so] they can prime the pump a little bit if needed to stoke their economies."

Bottom line: The powerhouses of the past could struggle for years to return to the prosperity they knew previously, while new economies rise up to challenge them.